Standing Committee F

[Mr. Roger Gale in the Chair]

Finance Bill

(Except clauses 4, 19, 23, 26 to 29, 87 to 92, 131 and 134 and schedules 1, 5 and 38)

Schedule 10 - Chargeable gains: taper relief: minor amendments

Amendment proposed [this day]: No. 30, in page 179, line 30, at end insert— 
'Conditions for shares to qualify as business assets 
 1A (1) Paragraph 4 (conditions for shares to qualify as business assets) is amended as follows. 
 (2) In sub-paragraph (2) for ''if at that time'' substitute ''if at the time it was acquired''.
 (3) In sub-paragraph (3) for ''if at that time'' substitute ''if at the time it was acquired''.
 (4) In sub-paragraph (4) for ''if at that time'' substitute ''if at the time it was acquired''.'.—[Mr. Flight]
 Question again proposed, That the amendment be made.

Rob Marris: On a point of order, Mr. Gale. The acoustics in this Room are absolutely appalling. I have average hearing for a man of my age and am finding it difficult to hear some hon. Members make their contributions in Committee. Talking to other members of the Committee over lunch, I found that they are having similar difficulties. I wonder whether the House could do something to improve the acoustics in the Room because the microphones are for the use of Hansard, not for boosting sound levels.

Roger Gale: I am tempted to say that hon. Members who are having difficulty should have voice training. The microphones are indeed for the use of Hansard only and there are no loudspeakers in the Room. However, I heard what the hon. Gentleman said—indeed, I heard what he said very clearly. Perhaps hon. Members will remind themselves of the need slightly to project in this Room. Nevertheless the hon. Gentleman has made a serious point that I do not wish to treat frivolously, and I shall draw it to the attention of the Serjeant at Arms.

Howard Flight: I will bellow as far as it is possible, Mr. Gale. It crossed my mind that the point just raised might have something to do with the subject matter.
 Amendment No. 30 deals with one of the injustices in the business taper rules. It also deals with the issue of those who acquired business assets before 2000 being taxed more than those who acquired them after 2000. 
 We have raised the issue before, and the Government presented a pragmatic argument, but it is important to remember that perceived fairness among individuals in the workplace is an important issue that allows a company to function well and its work force to be homogenous. Those who have been at a company for the longest, have put in more over time and have had their business assets longest perceive it as unfair that they should pay more tax. 
 We are not going to persuade the Government and, if it were possible, we would like to put the issue to a vote, but for various reasons amendment No. 84 has remained starred. We have raised the issue, and a pragmatic answer is not sufficient given the reality of the workplace. We shall not put the matter to a vote, however, and I beg to ask leave to withdraw the amendment. 
 Amendment, by leave, withdrawn.

Howard Flight: I beg to move amendment No. 31, in page 181, line 16, leave out 'means' and insert 'includes'.
 This is a technical amendment to cure a drafting defect. Schedule 10(5) defines the term ''interest in shares'', which is welcome because the acquisition or disposal of an interest in shares is often a significant taxable event. The definition in the Bill is probably too restrictive, however: it is confined to cases of co-ownership. It excludes cases in which an individual acquires a less than full interest in shares because, for example, legal title is lodged with a trustee, nominee or separate contractor under a separate contractual arrangement. 
 Circumstances in which that could occur include an award of shares to an employee subject to the risk of forfeiture, a case on which the Chancellor of the Exchequer introduced a new income tax regime in 1998. If that were not regarded as an interest in shares, an individual would not be regarded as having ownership for the purposes of taper relief and would be exposed to the full rate of capital gains tax upon the shares' sale. That would sabotage the thinking behind the Chancellor's reforms to the tax and penalise a large number of employees. I trust that the Economic Secretary to the Treasury will either tell me that there is a miraculous interpretation of the schedule that we have missed, or confirm that there has been a mistake in drafting, which the amendment would correct.

Ruth Kelly: Welcome to the Chair this afternoon, Mr. Gale. The hon. Member for Arundel and South Downs (Mr. Flight) has moved, as he said, a technical amendment. His concern, however, is not valid and I hope that I can persuade him of that.
 The definition of an interest in shares that will be introduced into the taper relief rules by schedule 10 corresponds exactly to that which applies to the new substantial shareholdings provisions, and does not represent any change for taper relief. It focuses on an interest in shares that people have if they own them together with someone else, which is exactly what we had in mind when we framed the taper rule. The reason why we have included a definition in the substantial 
 shareholdings provisions is because we were urged to do so by representative bodies that commented on the draft legislation that was published at the time of the pre-Budget report—they wanted clarity, and we have given it to them. Schedule 10 provides the same clarity for taper relief. 
 The hon. Gentleman suggested that a person who holds shares subject to forfeiture holds an interest in those shares as distinct from holding the shares themselves. The Inland Revenue's view is clear: for tax purposes the taxpayer holds the shares, and what matters is the beneficial ownership of the shares. The amendment would create uncertainty in an area in which we are bringing clarity, as it would leave wide open the question of what constitutes an interest in shares for taper relief. On those grounds, I suggest that the Committee rejects the amendment. I hope that the hon. Gentleman accepts my points and withdraws it.

Howard Flight: I am delighted to be advised that the concerns that our tax counsel raised about drafting have been covered. The second point is slightly grey on the area of law, but, if I understand correctly, it is covered by an Inland Revenue statement of practice. I beg to ask leave to withdraw the amendment.
 Amendment, by leave, withdrawn. 
 Schedule 10 agreed to.

Clause 47 - Use of trading losses against chargeable gains

Howard Flight: I beg to move amendment No. 12, in page 32, line 19, leave out from 'relief)' to end of line 21 and insert—
'for ''disregarding section 3(1) of the Taxation of Chargeable Gains Act 1992 and the effect of this section'' substitute ''disregarding the effect of this section and either section 2A (taper relief) or section 3(1) (annual exempt amount) of the Taxation of Chargeable Gains Act 1992 as the person elects for the year of assessment in question.''.'.
 The clause is intended to allow individuals to benefit from both taper relief and trading losses in the same year. The points that I shall make may be slightly convoluted. 
 As we understand the clause, the choice that will be presented to people for the early-stage operations of disposing of business assets could, unintentionally, be unattractive. Under section 2 of the Taxation of Chargeable Gains Act 1992, taper relief is given to reduce capital gains on business assets. It works to reduce taxable gains through a taper that depends on the length of the ownership of the business asset. It is available if the total chargeable gains for the year exceed current-year and brought-forward capital losses and the taper is applied to the net gain after deducting those capital losses. Section 72 of the Finance Act 1991 allows individuals to set trading losses against capital gains by treating the maximum amount of loss as a capital loss. The maximum amount is currently the net capital gain after taper relief but before the annual exemption. It should be noted that 
 as section 72 of the 1991 Act treats a trading loss as a capital loss, taper relief is applied to the net gain after setting off the trading loss. 
 The interaction of the two measures seems to mean that an individual could have trading losses in excess of their gross capital gains but, because of the way in which the taper works, could not reduce their capital gains to nil. The Bill increases the maximum amount of trading loss that can be set against the capital gain to the gross gain before taper relief. That in turn allows individuals with trading losses in excess of their capital gains to reduce the gains to nil. It also means that the benefit of taper relief is lost. That could penalise sole traders who need to realise funds by selling a business asset and use the cash raised to turn the unprofitable business around. The tax saved by each £10,000 of trading loss used in this way is £1,000 for assets held for more than two years, but £4,000 of tax could be saved if the loss were used against trading income. 
 The amendment would give taxpayers the option to elect to lose either taper relief or the annual allowance. That may sound an odd idea, but it might force the Government to explain why taxpayers must lose both. Although it would be relevant only in specific circumstances, the provision is a stealth tax nasty, although I believe that it was intended to be helpful. The Institute of Directors and the Chartered Institute of Taxation have also noted the anomaly.

Ruth Kelly: We have accepted that, under existing rules, the determination of the amount of trading losses that can be deducted from a gain is not as generous as it should be. The maximum amount is restricted to an amount equal to the gain that would be chargeable to tax after taking taper relief into account. The purpose of the provision is to correct that anomaly. It introduces a modest change that will increase the amount of trading losses that can be set against capital gains. As a result, trading losses can be deducted from a gain if they do not in total exceed it. We have been encouraged to make the change by representative groups and we would, rightly, be criticised if we allowed the anomaly to be perpetuated.
 Amendment No. 12 would introduce a change that was neither simple nor appropriate. It would allow a person to elect that trading losses be set against gains up to an amount equal to their total gains before the annual exempt amount was deducted. If such an election were made, the amount of the losses set off would be restricted to the total gains after taper relief had been applied, thus negating the effect of the clause. 
 The amendment would also provide taxpayers with the choice of making an alternative election: to set trading losses against gains up to an amount equal to the total gains before they are tapered. If such an election were made, the total amount of losses set off would be restricted to the total gains after the annual exempt amount had been deducted. The purpose of that alternative election is to allow a claimant to elect that their trading losses be used to reduce gains only to the level of the annual exempt amount and not, as now, to nil.
 We believe that it is right in principle that the amount of trading losses capable of being set against gains is not restricted by reference to the tapered gain or to the gain after the annual exempt amount has been deducted. Allowing trading losses to reduce capital gains down to the level of the annual exempt amount would also be inconsistent with the treatment of capital losses that arise in the same year as chargeable gains. The rule is that such losses are set off against gains to arrive at a net figure, without taking the annual exempt amount into account. The general principle that the amount of losses that can be deducted is not restricted by allowances applies equally to the taxation of income. Reliefs for trading losses, management expenses and so on are given by way of deduction from total income. There is no case for making an exception for setting off trading losses against capital gains. 
 Amendment No. 12 would have a further effect: most, if not all, claimants would have to make an election to ensure that they did not lose out as a result of the anomaly in the current rules. Therefore, the amendment would not be a simplification; instead, it would add significant complexity to the system.The elective element in clause 47 is merely transitional. If the new method of deduction is of benefit to people incurring trading losses in the tax years 2002-03 or 2003-04, they may elect for it to apply. However, from the tax year 2004-05 onwards, the new rules will apply to all relevant claims. Clause 47 makes the rules for trading loss relief operate in a simpler and fairer way.

Michael Jack: I ask this out of a genuine wish for information. The Economic Secretary is arguing that the proposal in the substantive clause should be accepted instead of the amendment of my hon. Friend the Member for Arundel and South Downs. Are the carry-forward provisions for unused trading losses and capital losses in the substantive clause or in the amendment?

Ruth Kelly: Obviously, I have been discussing the general clause, because it is necessary to understand it in order to understand the complexity that would be introduced by the proposal of the hon. Member for Arundel and South Downs. However, the substance is clearly in the clause rather than the amendment. Amendment No. 12 would complicate the process and run counter to the way in which relief is given for losses in other contexts. Therefore, I urge the Committee not to accept the amendment.

Howard Flight: I do not think that the Economic Secretary has answered the pertinent question raised by my right hon. Friend the Member for Fylde (Mr. Jack). To try to explain the matter in simple language, clause 47 corrects one anomaly but creates another one. In essence, a sole trading business in need of cash may be forced to surrender valuable tax losses for the future in order to save on the capital gains tax in the year in question. The Government are not happy with our amendment. Although the issue is specific, I cannot believe that the clause accords with
 Government policy, which is supposed to be about endeavouring to help small new businesses. The Chartered Institute of Taxation suggested that the implementation of the rule in clause 47 might be put back a year or two and that the treatment should be available by election, so that the individual can choose to sit on a small loss instead of obtaining taper relief to preserve losses to carry forward.
 One anomaly has been addressed but another situation has opened up. I do not think that that is the intention of the policy. The issue is quite technical, but I ask the Government to consider further the point that has been raised. On full digestion, I believe that they will agree that clause 47 is not exactly what they want.

Ruth Kelly: The change is essentially one that will reduce tax charges. People will be able to set a greater amount of trading losses against their capital gains and, by doing so, generally reduce the charge to tax. If it is helpful to the Committee, the carry-forward provisions are not changed by the clause. Unused trading losses carried forward can be set against future trading profits. I do not think that the concerns of the hon. Member for Arundel and South Downs are valid.

Howard Flight: What the Economic Secretary has just said is extremely important. For the sake of clarity, is she arguing that, if there are greater trading losses than are needed to take advantage of the taper relief, those that are not used can definitely be carried forward against future profits? Clause 47 does not quite say that. I would be interested to know how it works—not now, but in a letter perhaps. That is the exact point that we are endeavouring to get at; if it is covered, we are happy.

Ruth Kelly: I will write to the hon. Gentleman explaining the technicalities behind the interpretation of the clause. If there is anything there, we will certainly consider it.

Howard Flight: I beg to ask leave to withdraw the amendment.
 Amendment, by leave, withdrawn. 
 Clause 47 ordered to stand part of the Bill.

Clause 48 - Election to forego roll-over relief on transfer of business

Howard Flight: I beg to move amendment No. 65, in page 33, line 11, after 'apply', insert
'to the full gain arising on the incorporation of the business or a proportion thereof as specified in the election'.
 We have tabled the amendment to make the election apply only to part of the gain, as suggested by the Institute of Directors. The purpose is to allow people who incorporate their business and then dispose only of some of the shares in a two-year period to disapply incorporation relief on the proportion of the gain arising on the shares disposed, and not on the whole gain. The Chartered Institute of Taxation suggests a 
 full review of the reliefs available on incorporation, particularly if lots of unincorporated businesses arise; we discussed earlier the issue relating to people choosing to incorporate as a result of the tax advantages of incorporation. If that happens as we anticipate, the whole territory may need more consideration.

Ruth Kelly: The amendment would introduce an unwelcome complexity to the way in which capital gains tax incorporation relief applies. First, to give a little background to the Committee, I think that it would be useful to explain incorporation relief.
 Such relief enables the owners of an unincorporated business to transfer it to a company as a going concern without facing an immediate capital gains tax charge on the disposal of the assets transferred. The relief prevents capital gains tax acting as a disincentive for a growing business to incorporate. It works by rolling over the gains on the assets of the business into the shares acquired in the company. The gain comes into charge when the shares are eventually disposed of. 
 Incorporation relief does not always work to the taxpayer's advantage because any capital gains tax taper relief that has accrued on the transferred assets will not be inherited by the shares. That means that, if the shares are disposed of two years after the transfer, the business owner might have been better off if he or she had not received the benefit of incorporation relief. 
 The clause deals with that concern. It will allow the business owner to opt out of incorporation relief after the event, and incur the capital gains tax charge on the transfer of assets to the company with the appropriate taper relief intact. The rules proposed in the clause for an election to opt out of the relief are straightforward and simple. The change will reduce tax charges in the majority of cases where shares in the company are sold within two years of the transfer. 
 Amendment No. 65 would introduce a special provision for cases in which only some of the shares are sold in that period. That would introduce some significant additional complications, which I fear are not addressed by the amendment. For example, it would be necessary to cater for circumstances in which more than one class of share was involved and the different classes carried different rights to the assets that had been transferred. Furthermore, rules would be needed to deal with situations in which the assets transferred did not all qualify for the same rate of taper relief. 
 Clause 48 introduces a modest but worthwhile change that will reduce some of the stress of the incorporation decision. We are introducing it in response to specific representations that we have received. I am not attracted to the idea that we could tinker with it in order to deal with the points made by the hon. Member for Arundel and South Downs. The amendment would introduce additional significant complexity, and it is not clear how people would benefit from it.

Howard Flight: For simplification, I think that the Minister is saying that the Government do not agree in principle that it should be possible to make the election in respect of a proportion of a business corresponding to which shares are disposed of within two years of incorporation and to receive incorporation relief on the remaining part of the business. Why does she not feel that that ought to be addressed?

Ruth Kelly: This is a question not of principle but of pragmatism. Every taxpayer who made a disposal of shares soon after incorporation would, under the hon. Gentleman's proposal, feel compelled to work through every possible combination of full and partial elections to see which gave the best results. The legislation would have to be considerably expanded to cater for the different circumstances that needed to be addressed by a partial election.
 I do not dispute the fact that the amendment would benefit some people. However, I do not believe that it would be worth while to include the amendment because of the additional complexity that it would introduce, which would be to the disadvantage of the majority of owners who incorporate their businesses. What we hear from businesses is that they would like the tax system to be simpler. The proposals in clause 48 would help many people in a simple, straightforward way. It is the inherent complexity, not the principle, of the amendment that I cannot accept.

Howard Flight: This is not a huge issue, but it is one that was raised by the Institute of Directors, so some elements of business do have concerns about it. I understand the Minister's logic and do not think that the matter is sufficiently material to put it to a vote. However, the Government might, in the interests of fairness, think about whether there is a simpler way to address the point. I beg to ask leave to withdraw the amendment.
 Amendment, by leave, withdrawn. 
 Question proposed, That the clause stand part of the Bill.

Roger Gale: With this, it will be convenient to take new clause 5—Taper relief: holding period for business assets when roll-over relief on transfer of business assets applies—
 '.—(1) After section 162(3) of the Taxation of Chargeable Gains Act 1992 (roll-over relief on the transfer of business) insert—
 ''(3A) For the purpose of computing any chargeable gain accruing on the disposal of any new asset that is eligible for taper relief under subsection (3) above the qualifying holding period for taper relief shall be deemed to have commenced on the period after 5th April 1998 when the business so transferred under subsection (1) above was held and to have ceased upon the disposal of the new asset.''.'.

Howard Flight: In effect, our re-jigging of clause 48 by new clause 5 is in order to ensure that the taper relief clock is not stopped and then restarted under the election that is proposed in the Bill, the effect of which would be to waste the number of days during which the business was being incorporated because they were insufficient to contribute to a whole year to qualify for taper relief at the time of incorporation. If, at the time
 of incorporation, the business had been held for one year and 11 months, the 11 months would be lost if the election were made, and there would be one whole qualifying year for taper relief; that would make 50 per cent. of the gain chargeable under the taper relief provisions. However, if our re-jigging were accepted, the new shareholder would be able to sell the shares only one month after incorporating the business, and would then qualify for two complete holding years. In turn, that would mean only 25 per cent. of the gain being chargeable.

Ruth Kelly: I have already spelled out how clause 48 improves the way in which capital gains tax and corporation relief work. The clause is being introduced in response to representations, and it is simple and straightforward to understand. On those grounds, I have to say that I am not attracted to new clause 5.
 First, the clause aims to assign the taper history of the business assets to the shares received on the transfer, thus removing the need to opt out of incorporation relief. I would argue, however, that the assets of the business—for example, the buildings and goodwill—are not the same as the shares issued in exchange for them. It is right in principle that the taper clock on the shares should start when they are issued. 
 Secondly, the assets might in practice have several different histories for taper purposes. They might have been acquired at different times or be classified as a mixture of business and non-business assets. It would be extremely complex to translate accurately and fairly the different taper histories of the business assets into one value that could be applied to the shares received. New clause 5 deals with that neatly by ignoring the assets altogether and focusing instead on the earliest time after 5 April 1998 when the business was held by the person claiming incorporation relief. That is certainly a simple way of dealing with the issue, but it is also entirely inappropriate. It would, in effect, enable gains on all assets transferred to the company to benefit from a taper history extending back several years, irrespective of how long they had been assets of the business. 
 Clause 48 will allow a business owner to elect to opt out of incorporation relief and incur the immediate capital gains tax charge on the transfer of the assets to the company, but with the appropriate taper relief intact. That straightforward and simple change, which has been sought by representative bodies, will reduce tax charges in the majority of cases when the shares in the company are sold within two years after the transfer. On those grounds, I have no hesitation in recommending that the Committee reject new clause 5 and agree to clause 48 standing part of the Bill.

Howard Flight: In simple terms, the Minister is saying that the clause is an improvement on the present situation, which is the case. In new clause 5, we raise the potential unfairness that, in the example, 11 months could be lost if the election were made. The Minister says that it is not worth the complication of trying to deal with that. It is not a fundamental issue of the new regime, but it is worth thinking about.
 As we are debating clause stand part as well as new clause 5, I also raise the fact that the time limits imposed might be relaxed by a year. The limits proposed in the Bill are meant to tie in with deadlines for filing returns. The Institute of Directors has suggested more relaxed limits in order to correspond to the normal patterns for other claims such as trading loss relief, so that taxpayers can finalise all their elections together to optimise their tax positions.

Ruth Kelly: I believe that the deadline is long enough to enable people to make elections in time to obtain the most favourable tax treatment that could apply to their circumstances. That is the critical point. The longer the election period, the more complicated the record keeping and tax calculations will be and, in the end, the higher the interest payments become. The time limit is reasonable and representative bodies seem to be content with it.
 Question put and agreed to. 
 Clause 48 ordered to stand part of the Bill.

Clause 49 - Shares acquired on same day: election for alternative treatment

Howard Flight: I beg to move amendment No. 22, in page 34, line 15, leave out 'on same day' and insert 'by employees'.

Roger Gale: With this we may take the following amendments: No. 23, in page 34, line 17, leave out
'on the same day and in the same capacity'
 and insert 
'in circumstances in which those shares qualify as business assets for the purposes of section 2A by virtue of paragraph 4(2) of Schedule A1'. 
No. 24, in page 34, line 17, leave out 'on the same day' and insert 
 'during any thirty-day period.'.

Howard Flight: With your indulgence, Mr. Gale, may I point out that amendments Nos. 22, 23 and 24 were tabled as an alternative to amendment No. 21, so I wonder whether I could speak to all of them at the same time.

Roger Gale: Yes, if the Committee is happy for the amendments to be regrouped, given that they all relate to the same clause. We may begin to enter the territory of the stand part debate, but I am happy to include amendment No. 21 with the group that I announced. However, the Committee needs to be aware that if there is to be a Division on amendment No. 21, it will have to be moved separately at the appropriate time.
 Therefore, with the amendments that I have announced, it will be convenient to take amendment No. 21, in page 34, line 24, leave out from 'where' to ', or' in line 26 and insert 
 'paragraph 44, 45 or 46 of that Schedule (exercise of option to acquire shares) applies'.

Howard Flight: I thank you, Mr. Gale.
 Amendment No. 21 is our preferred way of addressing an issue of which the Government may be aware, as it has been raised by the leading lawyer on government law and enterprise management incentive schemes. Amendments Nos. 22, 23 and 24 are less effective alternatives to amendment No. 21. 
 The amendments attempt to cure what might have been a drafting oversight in the Bill. The intention is to provide employees with the right to elect that certain sales of shares can be charged to capital gains tax where there is a possible gain. The choice arises because, in certain circumstances, the shares may have been acquired under an option without being liable for income tax. The Bill cites two situations in which that can arise--the exercise of a company share option and one category of EMI option--but it omits too further types of EMI options. There is no sensible reason to distinguish between those different cases of EMI option, a category of tax-exempt incentives introduced by the Chancellor in 2000. It makes good sense to ensure consistent treatment, especially in a provision that is designed to be helpful and to simplify the tax position of employees.

Ruth Kelly: Clause 49 deals with the specific circumstance on which we received representations. We were told that some employees and companies periodically have a day on which they exercise options to acquire shares under the various share schemes operated by their employers. The employees then arrange to sell some of the shares to pay any income tax liabilities associated with the acquisition. Clause 49 focuses on a small subset of those cases. It typically applies where people who acquire shares in their company through different schemes on the same day have an income tax liability for some of those shares but not for all of them. The effect of the clause is to enable employees to pay that charge by selling some of their shares without incurring unexpected capital gains tax liability on the sale. It does that by changing the relevant rules.
 I am delighted that the hon. Member for Arundel and South Downs has recognised that amendments Nos. 22, 23 and 24 are not the appropriate way to deal with the issue, and has decided to concentrate on amendment No. 21. Although we are not minded to accept amendments Nos. 22 to 24, we can accept the hon. Gentleman's amendment--[Interruption.] I am pleased to see that the hon. Gentleman appreciates our acceptance. 
 We have given the matter careful consideration in the light of representations received after the publication of the Bill. I am satisfied that amendment No. 21 is within the spirit and policy of clause 49. The amendment alters the way that the clause treats shares acquired by exercising enterprise management incentive—EMI--options. The point is that some EMI options incur an income tax charge when they are exercised, and others do not. 
 Clause 49 divides shares acquired under EMI options into two different categories, depending whether an income tax charge arises when the option 
 is exercised, and distinguishes between the different types of EMI option. We are concerned that the provision should be simple for people to understand and apply, and the clause keeps things simple by dividing shares into just two categories: those acquired via a share option with no income tax charge attached are in one category; and all other shares are in the other. The different types of EMI option follow that division under the rules that we propose. 
 That is arguably the wrong result. Instead, all shares acquired via EMI options should be put in the same category as shares acquired via a share option with no income tax charge attached. That is a better result, because it will enable more people to take advantage of the new ordering rule for the disposal of shares. 
 I must point out, however, that re-shaping the two categories of shares in the way proposed by amendment No. 21 will not always produce a more advantageous result than that currently achieved by the clause. In certain circumstances, some people could find themselves unable to take advantage of the new provisions because of the proposed change. 
 We have been assured, however, that on balance it is better to make the change. No one will be worse off than they are under the current capital gains tax rules and the change will let some people take advantage of the new provisions in circumstances where they would otherwise not have be able to do so. 
 There is a second point to be considered: whether amendment No. 21 makes the rules proposed in clause 49 more complicated to operate. We are always concerned with compliance and the complexity of the system. On the face of it, the amendment introduces more complexity because the category of shares acquired by exercising options will include both shares with income tax liability attached and shares without. A mixed category looks more difficult to work out than a plain one. In practice, however, it should not be difficult to work out which category particular shares fall into. People should know whether shares have been acquired by exercising an EMI option, and knowing that will tell them which category of shares they have. 
 I am therefore persuaded that amendment No. 21 is sensible and would make a worthwhile change to clause 49. I am grateful to the hon. Gentleman for proposing it and invite the Committee to agree to it.

Howard Flight: I am delighted, and thank the Minister for her kind comments. I seek your guidance, Mr. Gale, on the technicalities. It appears that it would it be appropriate for me to beg leave to withdraw amendment No. 22 so that we can vote on amendment No. 21. I beg to ask leave to withdraw the amendment.
 Amendment, by leave, withdrawn. 
 Amendment made: No. 21, in page 34, line 24, leave out from 'where' to ', or' in line 26 and insert— 
'paragraph 44, 45 or 46 of that Schedule (exercise of option to acquire shares) applies'.—[Mr. Flight.]

Howard Flight: I beg to move amendment No. 66, in page 36, line 46, leave out 'acquired' and insert 'disposed of'.
 The amendment relates to one of the issues raised by the Institute of Directors. It seeks to apply the relief to all disposals after 6 April 2002, not only to shares barred after that date; hence it would bring forward the relief and let it apply to more people.

Ruth Kelly: Despite the Committee's natural enthusiasm for the previous amendment, I cannot support amendment No. 66, and I hope to persuade the hon. Gentleman that it is unnecessary. It would allow the new election to apply whenever the shares were acquired, but there is a strong practical reason for not doing that. It would add considerable and unwelcome complexity to the provisions.
 The normal rule for shares acquired before 6 April 1998 requires them to be pooled with all other shares of the same class in the same company. Extending the election to shares acquired before 1998 would therefore necessitate modifying all the rules relating to the pooling of shares. Restricting the new rules introduced by clause 49 to those acquired on or after 6 April 2002 avoids all the complications that modifying the pooling rules would bring. In any case, there was no need for the provisions to have an earlier commencement date, because we have satisfactorily addressed the problem put to us in the representations that we received. The intended target of the provisions are those people who sell some of the shares in question almost as soon as they have exercised the option to acquire them. Indeed, they may sell the shares on the same day. The usual reason for people wanting to make an early sale of some of the shares is, as we have heard, that they incur an immediate income tax liability on the exercise of their option and they want to pay that tax charge out of the proceeds. 
 There is another reason why amendment No. 66 is not acceptable. If the taxpayer elects for the new identification rule to apply, it affects all disposals of shares acquired on the day in question. The amendment, however, has effect only in relation to disposals on or after 6 April 2002. That would set up a conflict of rules, as some of the shares would have been disposed of before that date. As I understand the amendment, the normal identification rule would apply to disposals before 6 April 2002 and the new rule would apply to disposal of the rest of the shares. That is a recipe for utter confusion, as the rules would conflict with each other. 
 In any case, the amendment is entirely unnecessary. Given the reasons for clause 49, I recommend that the Committee does not accept the amendment.

Howard Flight: I accept that the primary intention of the clause is as described--to deal with situations when people are forced to sell shares because of the high taxation on group share option schemes. As I said earlier, the issue was raised by the IOD; it needed an
 airing, but it is not fundamental to the main problem that the clauses seeks to deal with. I beg to ask leave to withdraw the amendment.
 Amendment, by leave, withdrawn. 
 Clause 49, as amended, ordered to stand part of the Bill.

Clause 50 - Deduction of personal losses from gains treated as accruing to settlors

Howard Flight: I beg to move amendment No. 52, in page 37, line 15, leave out 'has' and insert
'and Schedule (set off of losses treated as accruing to settlors) to this Act have'.

Roger Gale: With this it will be convenient to discuss the following: Amendment No. 53, in schedule 11, page 185, line 22, leave out from beginning to end of line 44 on page 187 and insert—
 '(2) After subsection (5) (computation of tax in cases where gains treated as accruing to settlor etc in respect of trust gains) insert— 
 ''(6) Subsections (4) and (5) above shall cease to have effect for the year 2003-04 and subsequent years of assessment.''.'.
 New schedule 1—Chargeable gains: set off of losses treated as accruing to settlors— 
 Introduction 
 1 The Taxation of Chargeable Gains Act 1992 (c. 12) is amended in accordance with paragraphs 2 to 6. 
 Section 2 
 2(1) Section 2 (persons and gains chargeable to capital gains tax, and allowable losses) is amended as follows. 
 (2) In subsection (2) (computation of capital gains tax), for the word ''and'' at the end of paragraph (a) substitute— 
 ''(aa) any attributed loss accruing to that person, and''. 
 (3) After that subsection insert— 
 ''(2A) Where on a disposal a loss accrues to trustees of a settlement in circumstances where, had it been a gain that gain would have been attributed to another person by virtue of sections 77 or 86, then that person may elect for that loss to be an attributed loss accruing to that person for the purposes of subsection (2) above for the year of assessment in which the disposal occurs. 
 (2B) Attributed losses must be deducted first from any gains accruing to a person by virtue of sections 77 and 86 chargeable for the year in question before they may be deducted from any other chargeable gain.''. 
 Section 77 
 3 In section 77 (charge on settlor with interest in settlement), in subsection (1) at the end insert ''No deduction of any loss shall be made by the trustees in respect of any disposal which gives rise to a loss which the settlor informs them is to be regarded as an attributed loss for the purposes of section 2(2).''. 
 Section 86 
 4 In section 86 (attribution of gains to settlors with interest in non-resident or dual resident settlements), after subsection (1), insert— 
 ''(1A) For the purposes of subsection (1)(e) above no account shall be taken of any disposal which gives rise to a loss which the settlor informs the trustees is to be regarded as an attributed loss for the purposes of section 2(2).''. 
 Section 86A 
 5 In section 86A (attribution of gains to settlor in section 10A cases), after subsection (8) insert—
 ''(8A) For the purposes of this section, no account shall be taken of any disposal which gives rise to a loss which the settlor informs the trustees is to be regarded as an attributed loss for the purpose of section 2(2).''. 
 Section 87 
 6 In section 87 (attribution of gains to beneficiaries), before subsection (4) insert— 
 ''(3Z) In making any computations under this section, no account shall be taken of any disposal which gives rise to a loss which the settlor informs the trustees shall be regarded as an attributed loss for the purpose of section 2(2).''. 
 Commencement 
 7 This Schedule applies to persons and gains chargeable to capital gains tax and allowable losses in the year 2003-04 and subsequent years of assessment. 
 Election for Schedule to apply for years earlier than 2003-04 
 8(1) This Schedule also applies, if the person so elects, in relation to chargeable gains and attributed losses accruing to a person in any of the years of assessment 2000-01, 2001-02 and 2002-03. 
 (2) An election under this paragraph— 
 (a) must be made by notice given to an officer of the Board no later than 31st January 2005; 
 (b) where attributed losses may be regarded as arising in respect of two or more settlements, may be restricted to those regarded as arising in respect of the settlement or settlements specified in the election. 
 (3) All such adjustments shall be made, whether by way of discharge or repayment of tax, the making of assessments or otherwise, as are required to give effect to an election under this paragraph. 
 (4) Where— 
 (a) a person makes an election under this paragraph for any one or more of the years of assessment 2000-01, 2001-02 and 2002-03, and 
 (b) the effect of the election, or (as the case may be) both or all of them taken together, is to increase the total amount of tax that the person is entitled to recover from the trustees of a particular settlement for those three years under section 78(1)(a) of the Taxation of Chargeable Gains Act 1992 (c. 12) or paragraph 6 of Schedule 5 to that Act, 
 the trustees of that settlement must join in the election, or (as the case may be) each of them that has that effect or contributes to it.'.

Howard Flight: By way of background, when the rules on settlor trusts were changed, it was the Government's objective to render the settlor liable to the gains of income of such trusts as if they accrued to him directly. The provisions of clause 50 have been generally welcomed, but they raise two questions.
 If the clause is to apply to the deduction of losses from gains treated as accruing to persons, why should someone elect for it to apply the other way round, to deem losses to accrue and be deducted from gains realised by him? Given that the Government's main intention was to look through the trust, why does the provision work one way and not the other? Extensive legislation provides that settlors recognise trust gains as their own. As it stands, losses remain with the trustee and are netted off against gains within the trust before they are attributed to the settlor. 
 The amendment would extend the intended changes to trust taxation, to permit settlors to offset their losses against their direct gains. It would allow the taxpayer to choose between accelerating the benefit of losses in trust by taking the risk of higher taxable gains from the trust in future, and leaving the position as it stands. 
 The changes that we propose are designed to be compatible with schedule 11, irrespective of whether our amendments to that schedule are accepted. 
 Amendment No. 53 deals with a different issue, and I hope that the Economic Secretary will tell me that it is not necessary. As we understand it, the clause would also remove taper relief to settlors if they opted for the choice provided in it. We cannot see the logic for doing so when the trust's gains and losses are to be viewed as exactly pari passu, as if the settlor owned them directly. 
 I apologise for the length of new schedule 1, but we understood from the Bill Office that there was no alternative way to address the issues. It is necessary to achieve the transfer of losses and gains both ways, which requires a complete amendment to schedule 11.

Ruth Kelly: I should begin by setting out the background to settlor-interested trust provisions. I shall then explain what the clause does, before dealing with why I believe that the amendment should be rejected.
 People set up trusts for many and varied reasons. Some are purely tax-related; others are nothing to do with tax. The tax system respects the fact that there are trusts and that they are separate entities, but we must ensure that people cannot obtain an unfair tax advantage by putting assets into a trust. For that reason, we have long had special rules that charge the person who set up the trust—the settlor—tax in respect of gains realised by the trustees of a trust. The special rules apply when the settlor, or his or her close family, can benefit from the trust. The rules ensure that the right amount of tax is collected. The settlor may claim reimbursement from the trustees for the tax that he or she pays. 
 In broad terms, the clause restores the rules that applied before the introduction of the Finance Act 1998, so that settlors can set their available capital losses against gains that are attributed to them in that way. I readily admit that doing so will introduce complexity into the rules, because of the interaction with taper relief. It is because of that additional complication that we decided, when introducing taper relief in 1998, that it would be better to have a simple rule so that personal losses could not be offset against such attributed gains. However, we have come to the view that that can produce harsh results in certain cases and that it would be more equitable for people to set their personal losses against the attributed gains. 
 Amendments Nos. 52 and 53 and new schedule 1 would allow a settlor to obtain the benefit of losses realised by trustees and set them against all their gains. In effect, the amendments would set up a single pool for the gains and losses of a settlor from which they, or members of their close family, would benefit. 
 For settlors with genuine non-tax reasons for setting up trusts, the amendments would completely undermine the fact that they had transferred their property to them. For those settlors who set up trusts for tax reasons, it would make setting up trusts a one-way bet against the Exchequer. Indeed, those proposals would open up a real risk of tax avoidance, as people could use the election and juggle the timing 
 of disposals to maximise the deduction of losses against gains. The amendments would cost about £25 million a year without taking into account any behavioural change caused by people exploiting them for the purpose of tax avoidance.

Howard Flight: I do not understand the logic of permitting losses in a trust to be offset against personal gains, but not permitting gains in a trust to be offset against personal losses. As the Economic Secretary just said, tax legislation treats the situation as if a trust did not exist. I cannot see the logic of making a change one way but not the other.

Ruth Kelly: The trust rules on settlors and interest exist to ensure that the right amount of tax is paid. As I have explained, settlors have the power to claim reimbursement from trustees for any tax that they pay. Allowing settlors to set trust losses against personal gains would mean that a settlor would benefit at the expense of the beneficiaries of a trust. I shall explain that later.
 At the moment, trustees' losses are set against their gains. That reduces the sum with which trustees have to reimburse a settlor where a settlor pays tax on an attributed gain, which leaves more for beneficiaries. Under the proposals, the losses would personally benefit a settlor, and more would have to be paid out of that trust's funds to reimburse a settlor for attributed gains, which would leave less money for beneficiaries. That cannot be right. In effect, the amendments would give a settlor the power to benefit from a trust in a way not envisaged by the original deed of settlement. 
 It will come as no surprise to the Committee that in this very complex area of the tax code, amendments Nos. 52 and 53 and new schedule 1 are not free of errors, some of which would open up new tax-avoidance possibilities. The proposals would, for example, allow untapered losses to be set off against amounts attributed in respect of tapered gains. It is quite unfair to obtain such an advantage just by involving a trust in the process. The amendments and new schedule are wrong in principle, would have a significant cost and would give rise to tax avoidance, and I therefore ask the Committee to reject them.

Howard Flight: Will the Economic Secretary explain a point raised again by amendment No. 53? My understanding of clause 50 is that the quid pro quo of personal losses being offset against trust gains is the loss of taper relief on trust gains. What is the logic for that?

Ruth Kelly: I hope that I can reassure the hon. Gentleman on that particular point. I am advised that taper relief will not be lost under the clause. Trustees will not apply taper relief because the settlor will get it.

Howard Flight: I thank the Economic Secretary for that answer, which concerns an unfairness that has not been addressed. Although I appreciate the issue about the position of the settlor versus that of the beneficiary, the logic of having the offset one way and not the other is strange, but it is not a huge issue. The Government considered the situation that resulted in clause 50 and
 I now request them to consider it the other way, because I cannot believe that they intended their reforms to produce a situation that is worse than if the assets were owned directly by the settlor.
 I beg to ask leave to withdraw the amendment. 
 Amendment, by leave, withdrawn. 
 Clause 50 ordered to stand part of the Bill. 
 Schedule 11 agreed to. 
 Clauses 51 and 117 ordered to stand part of the Bill.

Clause 52 - Tax relief for expenditure on research and development

Question proposed, That the clause stand part of the Bill.

Howard Flight: I think that everyone, particularly large companies, is pleased with the inclusion of the clause in the Bill and with the fact that a volume-based scheme is being introduced for large companies. However, the difference between the schemes for SMEs and large companies will lead to difficulties when small companies grow into large companies and vice versa. We believe in principle that there should be some integration between the two and our amendments to schedule 12 address that in part.
 The complexity of the legislation and the continuing difficulty in determining whether expenditure falls within the definition of research and development will make it difficult for companies to decide in advance whether proposed expenditure will qualify for the new relief, and we have tabled amendments to schedule 12 to sharpen the definition. Those points of principle underlie the amendments that have been tabled to schedule 12.

Edward Davey: I welcome you to the Chair, Mr. Gale. It is important to tease out some of the policy issues that lie behind the approach in the clause. It has been long heralded and there has been significant consultation on the new research and development tax credit. The Government listened to that consultation and changed their original proposals. However, it is worth having a short debate on whether that approach alone is sufficient to achieve the policy objectives.
 There has been debate over a long period about the need for a research and development tax credit. Small allowances and support for research and development have been provided, but nothing as substantial as what is proposed now. Governments have said in the past that a tax credit would not do the job and have argued that most of the extra research and development that would gain the credit would have happened anyway, so there would be a high deadweight cost. The Government's proposal seeks to deal with that by trying to achieve extra research and development for 
 taxpayers' expenditure, but there has always been a question in many people's minds about whether the provision would make a marked improvement. 
 The reason for that scepticism is that until recently the results of several studies on how other countries use such tax credits were equivocal. Evidence from some countries showed that their effect was limited and that large amounts of taxpayers' money was spent, with no major behaviour change in the private sector. 
 The Government have been fortunate in many ways because further studies have been carried out in recent years to discover the objective of tax credits. Today's Government policy has been instructed by lessons from other countries. The policy is undoubtedly needed because Britain's performance on research and development has been lamentable for a long period, particularly when military R and D is excluded from the overall figures. I am convinced that we need to pursue the route that we are on, because international evidence is overwhelming—I speak as someone who is generally reluctant to go down the route of extra tax credits and reliefs. 
 I hope that the general policy direction receives support from all hon. Members. Can the Paymaster General reassure us that the debate does not rest here and that the Government will deal with other aspects of R and D policy? It would be out of order for me to mention competition policy, regulation policy and so on, but a more imaginative use of the grant system is needed. For example, ideas are being developed for an old-fashioned way of promoting R and D, namely offering prizes. The Government, a research institute or a royal society could offer a prize for the first person or body to achieve a particular breakthrough. Emerging evidence from the past few years suggests that that is a cost-effective way to promote R and D. Only one sum of money would be offered, but if one ensured that it was the right amount and that it created the right incentive, an awful lot of extra research would be carried out in the private sector for a small amount of public money. 
 The international evidence suggests that the provisions in the clause are the right approach, but I hope that the Government have an open mind to alternative approaches so that we can turn Britain's performance on R and D to better effect for our economy's productivity performance over the longer term.

Howard Flight: I support the comments of hon. Members. I shall add one specific and separate point on improving R and D performance. We could reconsider patent law and have a two-stage patent arrangement. The first stage would take products up to the point of licensing, and the second would deal with specific needs thereafter. That would be particularly valid to the pharmaceutical industry. In the round, we want measures that will increase R and D activity here rather than overseas. As well as tax incentives, the relative attractions of patent law are important.
 The Paymaster General (Dawn Primarolo): I shall make a few brief remarks, but the debate on these amendments should tease out in more detail many of the points raised by hon. Members.
 I welcome the positive comments from the hon. Member for Kingston and Surbiton (Mr. Davey). They echo comments by the Society of British Aerospace Companies, the Confederation of British Industry and the Federation of the Electronics Industry, to mention but a few.

Jim Cunningham: A number of us who have lobbied for several years appreciate the move on tax credits, but may I ask my hon. Friend a question? If we consider a company such as Rolls-Royce which has put considerable expenditure into research and development, is it the Government's intention to retain what they call lift-off loans, along with the tax credit?

Dawn Primarolo: I am afraid that I am not in a position to answer specifically the question posed by my hon. Friend, which is similar to the point that the hon. Member for Kingston and Surbiton made, concerning Government policy across the board in the encouragement of research and development. In the statement that my right hon. Friend the Secretary of State for Trade and Industry made last week on manufacturing, she specifically focused on aerospace as well as the pharmaceutical, chemical and car industries. The appointment of Sir Richard Evans to chair the innovation and contracts team that will advise the Department of Trade and Industry is crucial. Rolls-Royce itself may be the subject of debate in relation to some amendments.
 Yesterday, I was with David Marshall at a conference in the south-west, where there are a great many aerospace companies. We should be in no doubt that the tax credit will enormously help investment into research and development in this country. As we go through the amendments, we will see how the small and medium-sized tax credit on research and development and the larger company research and development tax credit fit together. 
 Underpinning all companies is a 100 per cent. deduction for research and development on current and capital expenditure. That underpins everything. On top of that, the two tax credits are boosting—they are super-plus credits. For the small and medium-sized companies, there is a 50 per cent. boost; for large companies, it is 25 per cent. Without drifting into the amendments, it will come out later in the debate why they are different, and what the Government are trying to achieve. 
 The historic position for the United Kingdom is that investment in research and development—with the exception of pharmaceuticals, perhaps—lags behind that of other major economies. To stick with the example of aerospace, we have the second largest aerospace industry in the world. We are second only to the United States, with a complete capacity to design, develop, manufacture and deliver. That is obviously enormously important, and great strides have been made in the past, but more must be made in the future.
 We have considered the position on international comparisons and what other countries are doing to give assistance to their companies for research and development. Putting in place the large company element, the value of the credit for research and development as a percentage of gross domestic product will be second only to that of Canada. That is the only G7 country that will—marginally—be ahead of us. We will be spending more, using the tax credit, than the United States or France, which have traditionally invested more than us.

Michael Jack: On a point of clarification, and I apologise if I have missed something, but will the Paymaster-General explain why she is talking in general terms about the operation of the research and development tax credit? For example, the Marconi part of BAE Systems in the United States consolidates its company accounts in the United Kingdom but incurs research and development expenditure of a qualifying nature in the United States. How does that operate in relation to the credit?

Dawn Primarolo: That is the subject of one of the amendments, but I shall make my general comments now. I have taken the challenge to compare and contrast that the right hon. Gentleman often poses to Ministers. Perhaps if I give my response in the general debate on the clause, it will set the matter in context. I shall compare and contrast how and why the small and medium-sized enterprises tax credit is different from the larger company tax credit.
 The obvious headlines are the rate of relief and whether it is payable; the subcontractor issue, which relates to the point that the right hon. Gentleman is making; intellectual property rights—there is a variation there—and the definition of research and development. Every one of those subjects relates to amendments, but I shall just discuss them briefly now. 
 The rate of relief for research and development costs for small and medium-sized companies is 150 per cent.; it is 125 per cent. for large companies. We have to draw a line somewhere. I should also just say as a caveat that in all the consultations the industry and professional associations were clear that we had to have simplicity, transparency and certainty. There was much discussion about the different ways to operate the credit, whether based on volume or incrementally. Hon. Members will have seen the outcome of that debate. 
 A reason for the difference between 150 and 125 per cent. is that small and medium-sized companies face particular difficulties attracting finance, especially for research and development. For example, banks often find it difficult to assess the worth of a project. That is a real problem for small and medium-sized companies. In addition, the difference in the effective rate of the subsidy is smaller for larger companies. Typically, it is 9.5 per cent. for small companies and 7.5 per cent. for large companies, because smaller companies pay tax at a lower rate. We are considering the introduction of a system, and more detailed explanations will come up when we deal with the amendments.
 Another issue is whether relief is payable. For small and medium-sized companies, the credit is payable for a loss-making company, whereas it is not for larger companies. Loss-making companies carry credits forward until they make a profit, but smaller companies cannot always do that. Obviously, we are trying to create an environment in which research and development are undertaken in this country. That is the purpose of the measure. The reasons that apply are the same as those that I gave for the size of the credit. For instance, the difficulty that small and medium-sized companies have in finding financing reflects the fact that the finance market sometimes fails specifically to assist them. 
 A payable credit also has public expenditure and state aid implications, and we had to be very careful and consider the laws. On subcontractors, we might discuss Rolls-Royce again when we deal with the amendments later. For small and medium-sized companies, the company funding the contract gets the credit, but for large companies, the company undertaking the research and development gets the credit. It is a natural preference to give the credit to the funding company, as it makes the decisions and takes the risks. However, for the large company, the credit essentially rewards all UK-based research and development, whether or not it is funded from abroad. That would not occur, on the whole, for small and medium-sized companies. By their very nature, they operate in one country. 
 To answer the right hon. Member for Fylde, we do not want to give credit, if we can possibly avoid it, for R and D undertaken elsewhere, by non-resident subsidiaries of UK multinationals. When we discuss the amendments, we shall see how our measures interact with tax treaties and other issues to ensure that that does not happen. By focusing on UK R and D, we have been able to deliver an enhanced rate of credit for the same Exchequer cost. What we have tried to do has been to produce a usable credit that maximises the rate at which we can pay it, by ensuring that it benefits UK investment. We have been greatly assisted in our detailed discussions in relation to tax by both the companies and the professional accounting bodies.

Claire Curtis-Thomas: My hon. Friend should be aware that I have recently been in discussion with some of my engineering colleagues, with particular reference to the R and D tax credit. First, I pass on their congratulations concerning the consultation that took place to ensure that the R and D tax credit was gifted to large companies. I also applaud the moves that the Government have made to ensure that the tax credit is passed on to third-party suppliers. As my hon. Friend will be well aware, large companies have, in the recent past, evolved their research capacity out of third parties. There was great concern that they would miss the bonanza. Can she comment on the future viability of such organisations, particularly with reference to the substantial enhancement for R and D?

Roger Gale: Order. I have allowed the hon. Lady to intervene, so I shall allow the Minister to answer the specific point if she wishes to do so. Clause 52 is a narrow clause; it is really a trailing clause for schedule 12 and, although I appreciate that these are complex issues, and interlinked, we are effectively entering into a stand part debate on schedule 12. As swiftly as possible, we should put clause 52 to bed then move to the amendments to schedule 12 and have a proper debate in the proper place.

Dawn Primarolo: It would make it far easier for me, as the Minister, to respond if we could deal with the points in context. If my hon. Friend the Member for Crosby (Mrs. Curtis-Thomas) will allow me, I shall return to her point on how the large company tax credit will operate vis-a-vis not-for-profit organisations—universities, for example—when we debate the amendments.
 My final two points of concern set the scene for the clause. The first is the issue of intellectual property rights. Small and medium-sized companies must retain some, however small, intellectual property rights within their R and D. There are obvious reasons for that, given their size. There is no requirement on large companies, and we must ensure that the United Kingdom research and development of foreign multinationals qualify in order to encourage inward investment, because that is part of the issue. 
 My second point concerns the definition of research and development. First, for small and medium-sized credit, we are using the DTI guidelines. After a great deal of discussion, we are using the same guidelines for large companies. They are based on the research and development definition of the Organisation for Economic Co-operation and Development and underpin the UK accounting standards and the R and D credits of other countries. That becomes crucial when making international comparisons and considering the possibility of what might be called double dipping, or getting credit from two different countries for doing the same research. That issue is part of the subject of the amendments. Although I welcome hon. Members' contributions to date, perhaps we are just setting the scene for how the provisions vary so that now we can tease out in the amendments why they do so. I should perhaps conclude my remarks on the clause and save further detailed discussion for the debate on the amendments.

Roger Gale: I call Mr. Jack, but very specifically on clause 52.

Michael Jack: Indeed, Mr. Gale, I would not have risen had I not wished to make a specific point while we are considering things in the round. In the Red Book, the amount of money that the Government are going to expend on research and development tax credits in the financial years 2003-04 and 2004-05 is shown as a flat figure of £400 million. Will the Paymaster General put my mind at rest on that? For example, if the R and D tax credit is more successful than she has outlined, can I assume that that £400 million is not an upper limit, that this is not a cash-limited figure?
 I was intrigued as to why the sum was deemed as flat instead of, for example, a rising trend of numbers. There may well be a very good explanation, for which I would be grateful.

Dawn Primarolo: The figure is not cash-limited and the figures assume the ability of the companies, on the information we have to date, to draw down on new investment to do that new R and D work. The right hon. Gentleman is quite right. If the measure is astronomically successful, the figure could rise. That would be good for the British economy as a whole, good for all the figures in the Red Book and not something of which the Government would take a dim view.
 Question put and agreed to. 
 Clause 52 ordered to stand part of the Bill.

Schedule 12 - Tax relief for expenditure on research and development

Howard Flight: I beg to move amendment No. 25, in page 189, line 9, after 'enterprise', insert—
'or a small or medium-sized enterprise which makes an election pursuant to paragraph 16A below'.

Roger Gale: With this it will be convenient to consider amendment No. 26, in page 194, line 35, at end insert—
'Regulatory simplification 
 16A. (1) In respect of any financial year any small or medium-sized enterprise may elect to forego the reliefs available to it under Schedule 20 to the Finance Act 2000 (tax relief for expenditure on research and development) and instead claim relief under this Schedule as if it were a large enterprise. 
 (2) Any election pursuant to this paragraph must be made in writing to the Inspector of Taxes prior to the end of the financial year in question.'.

Howard Flight: The two amendments are straightforward and echo the brief remarks that I made at the beginning of the stand part debate on clause 50. It is entirely understood and correct that the reliefs available to SMEs are more favourable than those offered to large enterprises. However, comments that we have received from industry leaders lead us to believe that some of the conditions attached to the reliefs for small companies could be onerous and it might be simpler for small companies to claim a less restricted, albeit less generous, relief under this new measure. It would also, obviously, for those who chose to do that, render the transition from small to large much simpler. Both the IOD and the CIOT have suggested that it would be sensible to move to a simple, volume-based system in general.

Roger Gale: The issues are complex and inter-related. As is my custom, I am perfectly prepared to allow a wide-ranging debate on the understanding that we do not then have a schedule stand part debate at the end. Insofar as Members find it convenient to discuss broader issues I am perfectly happy for that to happen.

Edward Davey: The principle behind the amendment needs applauding. If the Minister is not going to accept it, I hope that she can explain how she envisages companies growing and developing from one tax credit to the next.
 The Minister was gracious to the Committee in the previous debate and explained the background and how the credits would work. That was a helpful reminder but I am still not clear whether, if a company grows over the period of the R and D investment and moves from one definition to the next, it will suffer penalties. How will the transition in its growth be managed within the tax system? That is an important issue. We should be grateful to the hon. Member for Arundel and South Downs for tabling the amendment because, if the R and D is successful, the company will grow. The Minister might argue that if the company is successful, the tax credit should be capped because the earnings that result from its growth will mean that it no longer needs the subsidy. 
 Investors will be putting in risk capital and expecting a certain return. Has the Minister analysed the relation between the two credits? Will she be able to reassure investors that their expected returns will not suddenly diminish because of the complex interrelations in the system?

Dawn Primarolo: I am not attracted to amendments Nos. 25 and 26. In fact, they represent real danger for small and medium-sized companies with regard to the entitlement to the 50 per cent. addition. If there were an opt-out, they could come under pressure, because the 50 per cent. is given in return for what they undertake themselves. Subcontractors may be attached to a larger company, which will be entitled to the larger company benefits.
 The hon. Member for Kingston and Surbiton referred to what happens when companies grow. The amendments would allow a small or medium-sized company to opt out of the tax credit for those sizes of company and be treated as a large company instead. It is far from clear why a company would want to opt out of receiving 50 per cent. in favour of receiving 25 per cent. 
 Under our proposals, a small or medium-sized company will be able to claim the existing credit for a company of that size on its own R and D and an extra deduction of 50 per cent., rather than the 25 per cent. that will go to the larger companies. There will be a possibility of a cash payment if the venture is loss making. If the company opts out, it will lose the cash payment option and its tax credit is reduced from 50 to 25 per cent. In addition, a small and medium-sized company, having protected its position vis-a-vis the 50 per cent., may still be able to claim the large company credit for expenditure on work financed by someone else—for example, subsidised work or work by a subcontractor for a large company. 
 The proposed new paragraph in schedule 12 is headed ''Regulatory simplification,'' but it is hard to see what the simplification is or what other benefits it would allow. It would add to the length of the Bill, 
 create new uncertainty over the status of the small and medium-sized company and could cause serious problems. Hon. Members may find it easy to imagine a contract being drawn up between a large company that wants access to a tax credit and a smaller company that would receive a tax credit at a greater rate, that would benefit to a greater extent and that might come under pressure for contract reasons to opt out of the better entitlement. Therefore, I am not at all attracted to the amendment. 
 The hon. Member for Kingston and Surbiton suggested that the Bill would make the rules for small and medium-sized businesses too complex. He asked how a business would move from one category to another and suggested that it would be simpler to allow them to choose. The Government and officials at the Inland Revenue and the Department of Trade and Industry have put a huge amount of effort into discussing with small and large companies how to make the rules as simple as possible, while allowing benefits to flow from that.

Michael Jack: I am following the Paymaster General's argument carefully. Will she say what would happen if a large company took over an SME, whose R and D activity it found to be especially attractive, thereby giving the smaller company the enhanced credit that she mentioned a moment ago? Would the status quo of the smaller company remain, although it had become a wholly owned subsidiary of the larger company?

Dawn Primarolo: Perhaps I can answer that question in a slightly different way. It is not always possible to provide in legislation for such changes of status, and some discussion with the Inland Revenue will still be necessary. Of course, we hope that SMEs will grow into larger companies, and we want to encourage that. However, we should recognise that they will go through a transition. The effects of that transition will be eased by the definition of ''small or medium-sized enterprise'', which will allow a small company to continue qualifying as such in the year after it ceases to meet the criteria. None the less, at the end of the transition period, the company may fall within the definitions of ''large company'' and therefore fall within the tax credit regulations. We recognise that SMEs will be under a different pressure.
 We have tried to keep the scheme as simple as possible but it must be able to operate. The precise definitions of ''R and D'' and how they will work in practice following the DTI guidelines are still being discussed with the CBI and other trade and accountancy bodies, as was referred to on the Floor of the House. The detail of many of those issues will need to be set out, but the essential point is to recognise that SMEs operate under different conditions and, therefore, if they are to be able to undertake R and D, will attract slightly different rules from large companies. The two sets of rules must co-exist as simply as possible to deal with the transition across boundaries. That is what the Government have tried to achieve, and that is why the consultation exercise opted for a volume-based rather than an incremental 
 scheme. The points that hon. Members are making about complexity would be writ large if we had an incremental scheme. 
 Both the Chartered Institute of Taxation and the Law Society of England and Wales are of the view that the way in which the credit will operate will provide for a clear system in terms of how companies claim. Until we see that in operation, I cannot say that all of the matters are settled and dealt with. However, we believe that companies and professional bodies should continue discussing with us the finer qualities of the provisions. 
 I return to a point made by the hon. Member for Kingston and Surbiton. This debate is not the final word on how the provision will operate or on how we should review it and make sure that it improves. Nor it is the final word on Government policy in continuing to encourage research and development, growth and productivity because of their clear benefits to the British economy in terms of jobs and skill levels. 
 I hope that Opposition Members realise that an opt-out for small and medium-sized companies would be bad, because they could come under pressure to give up what clearly are good benefits. We want the two credits to interact with a sufficiently light touch to ensure that SMEs do not find themselves squeezed, or having to operate under unreasonably complex rules. That is certainly what everybody is saying to us. Frankly, if it is good enough after all the consultation, we should give the legislation the opportunity to work before adding complexities to provide for things such as opt-outs. 
 I ask the hon. Member for Arundel and South Downs to wait and see how the tax credit operates. If people still have problems, I am sure that the Opposition will come back next year, if the Government do not, with suitable amendments. I ask the hon. Gentleman to withdraw the amendment.

Howard Flight: The thinking behind the amendments was, first and self-evidently, that if an SME was nearly up to the limit, rather than getting caught with the problems caused by having one set of rules one year and another set the next, it might be more simple for them to go straight to the large company rules. The Minister has allayed that fear to some extent by saying that there will be a year's grace.
 Another thought behind the amendments was that, as we were advised, some of the conditions attaching to the more generous SME reliefs are pretty onerous and demanding, and that that might act as a disincentive to SMEs to take them up. The Minister has not said anything specific about consultation with SMEs, but one of the attractions of the large company reliefs is that they are drafted in a simple and straightforward fashion, whereas existing reliefs for SMEs are quite complex. If an SME was not sure whether it would meet the requirements of the more generous provisions, but was sure that it would certainly meet the wider requirements, it might want to take them up.
 The amendments are in essence probing amendments. As the Minister accepts, there is more work to be done in this area. However, I would like to hear a little more from her on whether the conditions attaching to existing SME reliefs are demanding and have therefore resulted in their underuse.

Dawn Primarolo: We have received no representations that the rules are too complex—quite the reverse. The SME tax credit is more generous and has a lighter touch than the large company tax credit. It should precisely recognise the slightly different circumstances of SMEs. I cannot understand the hon. Gentleman's logic. He says that the provision is too complex, so it should be made less complex by adding highly complex rules under which a company could give away all the extra benefits—Lord knows why it would want to—and pretend that it is a large company. A large company would be given less than a small or medium-sized company. Small and medium-sized companies that become large companies are protected in the transition, which is appropriate, given the planning.
 The hon. Gentleman needs to understand that SME tax credit for R and D was provided for in the Finance Act 2000. There has not been a stampede to the Treasury's door from SMEs saying that they want the scheme for large companies instead, because it is less generous.

Howard Flight: The Paymaster General has not answered the key question that lay behind the input that we perceived, which is about how much take-up there has been from provisions of the 2000 Act. We have been advised that many SMEs have found the arrangements too complex to bother with. The crude thinking was that, on the basis of the large company schemes being much simpler although not as good, it would be better for SMEs to take them up. Have the 2000 Act provisions been taken up?

Dawn Primarolo: My understanding is that they have, but I do not have the figures on take-up to hand. The hon. Gentleman will understand that investments in R and D require a long planning period before the tax credit comes in.
 I find it incredible that the hon. Gentleman is asking me to believe that plenty of criticism has poured to him so that he can make his point in Committee, but not to the Government, who could have amended the legislation and ensured that there was no problem. The subject has not been reported to us as a problem by SMEs. 
 We have invested a great deal of time and taxpayers' money in the R and D credit. The policy is important to the Government, and I can assure the hon. Gentleman that if it was not working as well as it should and required amendment, we would take those considerations on board and do our best to amend it. The Inland Revenue is full of talented and able people, but mind readers they are not. Given that no one has pointed out why the scheme should be changed, it is 
 difficult for me to engage with the hon. Gentleman in a theoretical discussion on a complexity about which no one is complaining. 
 Indeed, the reverse is true: the scheme has been widely welcomed and is being used. People have had nearly two years to comment on it, and complaints are not coming through. If they do, I shall ensure that they are looked at, because I want the policy to be a success.

Howard Flight: I am very glad to hear the Paymaster General's comments. She will find that the take-up has been extremely disappointing, and that there is something in the issue of complexity. However, I do not want to bang on about the matter. If my claim is substantiated, I am glad to hear that the Government will want to consider simplification. The amendments simply sought to offer a short cut to simplification, but the matter has had a valuable airing. They were probing amendments, and one or two interesting facts have come out of the discussion. I beg to ask leave to withdraw the amendment.
 Amendment, by leave, withdrawn.

Howard Flight: I beg to move amendment No. 54, in page 189, line 24, at end insert—
 '3A. A company's ''qualifying R and D expenditure'' shall not include any amount in respect of which, under the law of any territory outside the United Kingdom, the company is entitled to a deduction for the purposes of any foreign tax which exceeds the amount of such expenditure.'.
 I had understood, when the main reliefs were announced, that they would relate only to R and D undertaken in the UK and there was an issue about the relative attractions of Canada and other such places. I was interested to hear the Paymaster General say that that was how the measures had been cast. As far as our adviser and I can see, clause 52 contains no restriction that any expenditure benefiting from enhanced tax relief should be incurred in the UK. Conceptually at least, the relief could be used to allow foreign groups to obtain additional tax relief for R and D expenditure routed through UK companies. The UK Exchequer could suffer without any additional R and D being carried out here. 
 The Paymaster General referred to the scope of the relief to R and D carried out in the UK being limited by European Union law. The amendment seeks both to limit the scope of any potential abuse by ensuring that no relief is given where another territory is giving a super-deduction for the same expenditure under its tax laws and to make it clear that double dipping is prohibited.

Dawn Primarolo: I thank the hon. Member for Arundel and South Downs for his assistance in scrutinising the legislation to ensure both that companies do not use it in a way in which it is not supposed to be used and that expenditure is directed precisely to enrich the research and development capability in the UK.
 The hon. Gentleman specifically raised the problem of tax incentives in other countries and how foreign multinationals that are not based here would operate. We raised that issue in last year's consultation. If a company is able to claim a tax incentive in another 
 country, why should we give another credit in the UK? However, we decided that such a restriction was not justified, and the problem that he has identified would not exist. Our new credit focuses on direct R and D costs—staff costs and consumable stores—of a company within the charge to UK tax, and the bulk of such costs would not be eligible for any foreign tax incentive. We are not giving credit, in general, for the costs of subcontracted work, including work subcontracted to a foreign business. That is another crucial difference between the tax credit for small and medium-sized companies, which would probably not have the ability to subcontract work to a foreign business, and the tax credit for large companies. Very little expenditure will actually qualify for an incentive in more than one country. 
 If we were to introduce a restriction, it could cause some multinational groups to locate outside the UK research and development activity that might otherwise have been conducted here, which is not the result that we want. The amendment is unnecessary in any case, because foreign R and D relief would almost certainly be cancelled through the operation of double taxation relief. Foreign tax relief will reduce the amount of double tax credit given against UK tax, allowing the UK Exchequer to benefit from foreign R and D credit. A company's overall tax liability will be reduced only by the UK tax credit, and not by a foreign tax credit as well. To go further than that and deny the UK tax credit would just be punitive and unnecessary. 
 Others have scrutinised that point, and the detailed views that we received in the consultation argued against such a restriction, which would inadvertently work against R and D. As well as large companies, a number of well-respected representative bodies, including the Chartered Institute of Taxation, the Institute of Chartered Accountants in England and Wales and the Law Society, criticised the idea. For those reasons, and after careful consideration of the design, the Government are satisfied that we can prevent such a restriction. However, if it turned out that something untoward was going on, and there was what we politely call ''tax leakage'', we would deal with it. We are trying to strike a balance throughout the Bill between protecting the Exchequer and recognising the commercial reality of the how companies operate.

Iain Luke: The hon. Member for Arundel and South Downs made a valid point. I know from being involved in the all-party group on tyres, and from comments from the Chartered Institute of Taxation, that the tyre industry is wholly owned by companies outwith the UK, which is unfortunate given the UK's pioneering role. Given the complications of decisions on tax credits, the only thing that will save the industry is R and D credit. It will allow the industry to invest in high-quality techniques, which would beat off competition from the far east. The hon. Gentleman's points were pertinent. Will the Paymaster General bear in mind the tax credit issues that relate to the tyre industry?

Dawn Primarolo: Certainly. My hon. Friend raises an important point about how the tax credit operates. It will encourage research and development in the United Kingdom, particularly in industries that large multinational companies may be financing from outside the UK. My hon. Friend's example was of the tyre industry being financed from outside the UK when its R and D occurred here. Such an industry would qualify for tax credit.
 The hon. Member for Arundel and South Downs made a slightly different point. He wanted to ensure that companies did not get double credit—from the United States and from the United Kingdom—for the same R and D. My response was that the operation of tax treaties, and the rules for calculating tax, would ensure that that did not happen. A multinational that accessed R and D tax credit in another part of the world could not access R and D tax credit in the UK—even if it tried to get it for different R and D—because that would make for complicated rules on distinguishing where research happened. We want our tax treaties and tax system to operate normally by ensuring that there is no double relief. I hope that I have reassured the hon. Gentleman that we are quietly confident that our rules will prevent behaviour that could cost the Exchequer money.

Howard Flight: I am pleased to hear the Paymaster General's response, for which I thank her. The fundamental objective is to ensure that R and D happens here. I understood from discussions with CBI representatives last autumn that we are in a competitive game, particularly with Canada where there are attractive incentives—hence the argument in favour of the provision. The double dip is a secondary point. It strikes me that the schedule has been cleverly crafted, particularly within EU constraints, so that the net effect is that virtually all R and D takes place here. I beg to ask leave to withdraw the amendment.
 Amendment, by leave, withdrawn.

Michael Jack: I beg to move amendment No. 77, in page 189, line 30, after 'incurred', insert ', whether directly or indirectly'.

Roger Gale: With this it will be convenient to take the following amendments: No. 78, in page 189, line 32, after 'stores', insert ', or
 (c) on accommodation.'. 
 No. 79, in page 189, line 32, at end insert 
', or 
 (c) on applicable direct overheads, such amount to be calculated on a just and reasonable basis.'.

Michael Jack: Amendments Nos. 77 and 79 are conveniently linked because they deal with aspects of staffing costs relating to the research and development tax credit. Amendment No. 78 deals with matters concerning accommodation. I would like to proceed carefully through this small series of amendments because their implications are quite technical.
 Amendment No. 77 deals with the fact that many large companies and groups outsource certain expenditure. Indeed, many groups have a service company through which all their staff are employed, and where the costs are recharged to the relevant individual companies. As the Paymaster General will know, in terms of the R and D tax credit, matters connected with staffing costs that are allowable are provided for by paragraph 17(b) of the schedule, which states when read in conjunction with the first part of the paragraph that the provisions of paragraph 5 of schedule 20 to the Finance Act 2000 apply for the purposes of schedule 12 as they do for schedule 20. The definition of staffing costs of a company provided for by paragraph 5 of schedule 20 to the Finance Act 2000 is the one relevant to amendments Nos. 77 and 79. 
 As for amendment No. 77, the proposed legislation does not accommodate the fact that outsourcing costs or group recharges would qualify for relief even when expenditure relates to staffing costs, as the payroll is not undertaken by the company carrying out the research and development. I understand from those in the accountancy profession that that is likely to be a significant issue for large companies and groups. In their judgment, it does not seem to be in the spirit of the legislation, which is what the Paymaster General outlined in her earlier remarks: to encourage research and development in the United Kingdom. The amendment would ensure that relief would be given for outsourcing costs and intra-group recharges, where such expenditure would otherwise fall in paragraph 4(3). 
 Amendment No. 79 uses as its base the same analysis of the staffing costs, so I will not repeat that. Again, we have a situation in which many large companies calculate a fixed-cost rate when they apply to relevant projects being undertaken in order to provide suitable costing information for management accounting purposes. The cost rate typically includes employee costs and a measure of overhead, and I am sure that the Paymaster General will immediately appreciate that that is an important accounting point. 
 In order to comply with the proposed legislation, apart from determining which projects are qualifying research and development, many large companies will have to deconstruct the project cost rate to separate out the pure employment costs—hence the point I was making about the definition of allowable employment costs in the provision. To determine the qualifying staffing costs on that strict basis, as referred to in the previous amendment—paragraph 5 of schedule 20 to the Finance Act 2000—many companies will have to set up completely new systems of recording time and costings. 
 Although the basis of schedule 20 may be relatively simple to operate for SMEs with a small number of R and D staff, it is not appropriate for large companies that have several thousand employees engaged in research and development. Again, it is felt that that does not accord with the Government's objective of encouraging R and D in the United Kingdom. Therefore, the proposed solution as exemplified in the amendment is that qualifying expenditure for research 
 and development should include not only the staffing costs of those employees engaged in research and development but an appropriate element of direct overhead. It is felt that that would help large companies to continue with their current operating cost management systems and make it easier to apply and reduce compliance costs. That is complicit with what the Paymaster General said was the objection of the large companies. 
 I turn to amendment No. 78. Under the Finance Bill provisions, we are aware of what qualifies in terms of relief for R and D. However, the definition of qualifying expenditure does not include accommodation costs. Where a lease is entered into for the purposes of providing relevant accommodation for R and D, tax relief will be available only on 100 per cent. of the rental payments, rather than 125 per cent. of the new provisions. Given, for example, the unique conditions, such as sterile environments, that might be required for research and development in the electronics or aerospace industry, it is felt that it is inconsistent not to allow research and development relief for relevant accommodation costs. The proposal for that, therefore, is that qualifying expenditure for R and D should include not only the staffing costs, to which I referred in previous amendments, but the relevant accommodation costs.

Mark Hoban: I congratulate my right hon. Friend the Member for Fylde on the way in which he has introduced the series of amendments. He has picked up some important issues about what forms a cost base for R and D activity, and he has highlighted the Bill's narrow definition of the type of costs that will gain, in the words of the Paymaster General, super-plus relief.
 We have to recognise that a lot of R and D takes place in very expensive premises. People who travel up the M1 regularly will have seen the research centre of GlaxoSmithKline in Hertfordshire. That is an obvious and powerful embodiment of the issue of whether we give the extra, enhanced relief to office costs and the costs of property that large companies incur when they engage in significant amounts of R and D. If we are to encourage and stimulate research and development in the United Kingdom, we must ensure that a broad base of costs is taken into account. I shall be intrigued—if the Paymaster General has the information—to know what representations have been received from pharmaceutical and electronics companies about the structure of costs that they incur. My concern is that if we give relief on a relatively small part of their cost base, it will not trigger the increase in R and D expenditure that we hope would arise from the introduction of this relief for large companies. 
 I support the amendments proposed by my right hon. Friend. He has raised some valid points that strike to the core of whether the relief will be attractive and will stimulate the growth in R and D expenditure that the Paymaster General hopes for.

Dawn Primarolo: Unfortunately, I have to tell the right hon. Member for Fylde that I do not think that his amendments will be helpful. If it came to a vote, I
 would have to ask my hon. Friends to vote against them. I hope that I shall be able to explain why. The hon. Member for Fareham (Mr. Hoban) touched on what industry might say to us. It would be inappropriate for me to name companies. However, to date with regard to, for instance, outsourcing IT, staffing or accommodation costs, we have received only one representation from one company. We are discussing that with that company, which is not in pharmaceuticals.
 The response so far from all the companies involved, given that the matter has been in consultation for so long, has been very positive. Of course we accept, as do the companies, that it is difficult to draw lines, particularly in relation to staff costs where staff are involved in R and D to varying extents. However, the R and D guidelines on this issue attempt to make a reasonable distinction. In developing those guidelines we have been, and continue to be, in detailed discussions on the operation of the new tax credits with the very industries to which Opposition Members refer. 
 The amendments are designed to include as qualifying expenditure for large companies—interestingly enough, no equivalent measure is proposed for SMEs—''indirect expenditure'' and two new items of expenditure besides staffing costs and consumables, namely accommodation costs and overheads. 
 The inclusion of indirect costs by amendment No. 77 could give the principal credit for some element of subcontracted expenditure, which could effectively mean that a double credit would be awarded. The international situation, where a company could receive a credit from more than one country, which we were discussing in a previous debate, could occur here in the UK through the operation of those rules. The companies would receive a double credit, as the design of the large company scheme assumes that credit goes to the person carrying out the work. The amendment might not work, as paragraph 4(2) already requires a company to carry out R and D directly. 
 Including the amendment would mean that the Government might pay twice for the same research and development, perhaps raising our costs by as much as £100 million, which does not seem sensible. In addition, it would require complex rules to define the term ''indirect''. By widening the scope of the R and D tax credit, amendments Nos. 78 and 79 would also increase the cost. If the credit is to achieve its aims, it needs to remain focused. The more things that qualify, the lower the rate we can afford and the less the impact of giving that boost to R and D. That has to be part of the equation and of the balance in the Government's consideration of how much can be afforded and where that can be directed to greatest effect. 
 The amendments would add complexity. Companies would have to track a wider range of costs, for example making more apportionments for shared costs such as electricity.

Mark Hoban: The Paymaster General needs to reflect on the fact that many such costs are calculated and apportioned by companies anyway. Their own costing
 systems for R and D for manufacturing will allocate costs among various activities. I am not sure that complying with the terms of the amendments moved by my right hon. Friend the Member for Fylde would require businesses to do much more than they do at the moment. There is a greater risk that they would have to deconstruct their existing cost bases to ensure that they comply with the schedule as drafted.

Dawn Primarolo: I want to come to the point about deconstruction because the hon. Gentleman is making that point with regard to one company only, as far as we know. It is a large and important company, but to make room for the difficulties of one company by making the rules for all companies complex is not a sensible approach and would risk adding distortions and increasing costs. For example, some companies would be able to claim a credit for a proportion of their rent but not for a proportion of the cost of a new building. That is clearly not right, especially given what the hon. Member for Fareham said about competing and contributory costs.
 If R and D is outsourced, the company that carries out the work will qualify, so if we were to allow the principal contractor also to qualify, two payments would be made. That takes us back to the point that I was making about double credit and back to our discussion on a previous amendment about the pressure from large companies to make smaller companies opt out of their 50 per cent. to gain access to 25 per cent. Then there is the subcontracting issue, which is dealt with by virtue of the fact that the SMEs get access to the R and D work. 
 Work may be outsourced to a company resident in another country. It would be out of the question to allow that because it would be inconsistent with the focus of the tax credit on R and D undertaken in the United Kingdom. As I have said, it would be inappropriate for me to name the company that has recently raised several issues relating to deconstructing costs, the ratio of subcontracting and the huge importance of IT in research and development. At least one large company that has spoken to us will experience some difficulties because of the substantial contracting out of those costs. 
 I can tell the right hon. Member for Fylde that, although I am not attracted to amending the Bill to make room for one company, because it will make the provisions more complex for others, none the less some important issues are being discussed further with that company to try to ensure that the rules do not inadvertently exclude it from receiving R and D money to which it would have been entitled. Hon. Members must keep it firmly in their minds that the purpose of the tax credits for small and large companies is to recognise that there might be subcontracting, but to bring that R and D to the UK, so that we get the benefit. There would be no point in us funding, through a subcontracted chain, subcontractors outside the UK, because we would not get the benefit 
 of the R and D. The principal company will have to consider that, but in asking hon. Members to reject the amendment, I can tell the right hon. Member for Fylde that issues surrounding IT outsourcing and staff costs have been drawn to my attention by a particular company, and we will do our best to address those issues without compromising the underlying principles of the tax credits. I hope that, on that basis and having aired his points, the right hon. Gentleman will feel able to withdraw the amendment, at least for now. If he is not satisfied, I am sure that he will return to the issue in future.

Michael Jack: I am most grateful for the way in which the Paymaster General dealt with the issue of tax credits. I am in the fortunate position of not knowing to which company she was referring, because those in the accounting profession who raised the matter with me also did not name it. In a way, I am delighted not to know, because she has implied that in relation to the IT outsourcing there may be wider issues.
 Returning to the Paymaster General's wider comments, we shall have to see how we go, as we are in uncharted territories. I should say at the outset that it would be foolish to proceed to press to a Division amendments that would act in the context of untested legislation and might not deliver what was required. However, much of what the Paymaster General is saying could form the basis of future discussion. Perhaps in due course some guidance, a practice note or an appropriate publication could be produced to assist people in understanding the area covered by the amendments.

Dawn Primarolo: I am grateful to the right hon. Member for Fylde for giving way immediately. I can assure him that we intend to produce guidance or practice notes, and that the discussions on that subject are taking place. Guidance would ensure that companies could navigate the more difficult points, be clear about their entitlement and receive it.

Michael Jack: I am most grateful to the Paymaster General. I do not want to detain the Committee with having more forensic examinations and pursuing the cost aspects, but there are some complex matters in the part of the Finance Act 2000 from which I quoted. For example, some may find complex the issue of what percentage of a person's time counts towards R and D and ask whether a smaller percentage does not count towards it.
 Amendment No. 78 deals with accommodation costs. I do not want to put words into the Paymaster General's mouth, but it seemed implicit that the subject might be reconsidered. The Government would surely not want to make it unnecessarily difficult for specialist facilities required for R and D to benefit from the provisions of the credit. I know from my constituency experience with BAE Systems that the company has had to construct a specialised facility to design the stealth characteristics of modern fighter aircraft. I would hate to think that the financing of such a facility could not benefit from credit relief because of a small technicality.
 I take comfort from the way in which the Paymaster General responded, and look forward to reading the clarifying material. As she says, we may want to return to the matter when we all have more experience under our belts. I beg to ask leave to withdraw the amendment. 
 Amendment, by leave, withdrawn.

Dawn Primarolo: I beg to move amendment No. 61, in page 192, line 24, leave out 'any' and insert 'that'.
 The amendment corrects a deficiency in paragraph 11. As with the credit for small and medium-sized companies, our aim for the large company measure is to keep the concept of R and D in step with accounting definitions. Accounting principles allow a company in some circumstances not to reflect R and D expenditure in the profit-and-loss account but to defer it to a future year when it may be matched by some income from the activity. In line with that, we wanted to give the R and D tax credit when expenditure appears in the profit-and-loss account, but the Bill as drafted produced the opposite effect by using the word ''any'' in paragraph 11(2). I know that the Committee will accept the amendment as I have explained and apologised for the drafting error. 
 Amendment agreed to.

Michael Jack: I beg to move amendment No. 80, in page 194, line 44, at end insert—
 '17A (1) Paragraph 5(1) of Schedule 20 to the Finance Act 2000 shall be amended as follows.
 (2) In paragraph (a) delete ''other than'' and insert ''including''.
 (3) In paragraph (b) after ''company'' insert ''together with any Class 1A national insurance contributions paid by the company''.'.
 The amendment again goes to the minutiae of the measure, but it is on an interesting detail. As I understand the proposals, when an employee takes a cash option instead of a company car, the cash option will qualify for R and D relief. However, the provision of a company car as a benefit in kind will not. The amendment addresses that issue, which is undoubtedly important to those to whom the company car matters.

Dawn Primarolo: The amendment broadens the cost base of the credit and reduces the rate of the relief, which can be ill afforded in such a targeted measure. It would be distortive, because although we give R and D tax credits on current expenditure, the credit for benefits in kind and class 1A national insurance would not all be for current expenditure. The design of the scheme tries to avoid the complexity and distortion that are created by focusing on simple staff costs and consumable stores, which are the main extra costs of R and D. The scheme tries to stay clear of complex apportionments.
 I believe that the right hon. Gentleman's amendment would give us much more complexity for no increase in R and D expenditure, so I ask my hon. Friends to reject it if it is put to the vote.

Michael Jack: My amendment was very much a probing one, and in a way I felt that it was slightly mean to table it in the light of the bigger picture that the Paymaster General outlined. None the less, it is important to have heard the Government's view on the subject. I beg to ask leave to withdraw the amendment.
 Amendment, by leave, withdrawn. 
 Schedule 12, as amended, agreed to. 
Further consideration adjourned.—[Mr. Sutcliffe.] 
 Adjourned accordingly at three minutes to Seven o'clock till Thursday 23 May at half-past Nine o'clock.